When a condo owner in arrears on assessments declares bankruptcy, a condo association often expresses concern about the effect of the bankruptcy on its ability to collect pre- and post-bankruptcy assessments.

The bankruptcy code states that fees or assessments that become due and payable after filing for bankruptcy protection are exempt from discharge. Any amounts owed prior to the filing the bankruptcy case are included in the discharge but may be reduced to liens against the property.

Under the New Jersey Condominium Act, NJSA 46:8B-21 (b), a condo association is entitled to a limited priority lien – over previously recorded liens (including mortgages) – for six months of “customary condominium assessments.” This statutory priority ensures that condo associations will be paid for some of the delinquent assessments instead of having their entire lien extinguished in foreclosure sales. Foreclosures often go hand in hand with bankruptcy.

In a Chapter 7 bankruptcy, pre-petition delinquent assessments are discharged as to personal liability of the debtor. A lien may be filed against the property. Post-petition assessments are not dischargeable. Thus, the debtor remains responsible to pay the fees until the property is sold or transferred.

In a Chapter 13 bankruptcy, if the owner stays in the home and retains ownership, the owner is responsible to pay pre- and post-due fees.

Aside from the six month statutory priority lien, in a Chapter 13 bankruptcy, the concern is that at the completion of the debtor’s Plan, remaining post-petition fees after the priority lien may be discharged as wholly unsecured. If the mortgage on a property exceeds its value, the community association’s lien may be stripped off the property, making the lien unsecured. A homeowner may seek to avoid or reduce the amount of the condo association’s secured claim if the bankruptcy court treats it as a statutory lien. Statutory liens in a Chapter 13 case can be avoided or stripped down to the extent they impair equity in the property. If the lien is stripped off, the owner would not be personally liable for payment but the association would retain an interest in the property as a secured creditor. The association may then pursue its lien through foreclosure. However – what about the all too common situation involving a property that is valued less than the mortgage encumbering it?

In In re: Mark and Ronda Rones, an amicus brief from the Community Associations Institute supported the community association’s successful challenge to an owner’s attempt to strip the assessment lien off the subject property. Reversing a Bankruptcy Court decision that allowed a condominium owner to avoid paying a lien in full under a Chapter 13 plan, the District Court found that an association’s lien may have priority. The issue in these cases is whether a condominium lien is a fully secured claim under bankruptcy law, or a partially secured claim which may be “stripped off” in a bankruptcy plan.

In the Rones case, the Whispering Woods Condominium Association’s recorded a lien for $18,761 for unpaid association fees and assessments – $1,494 was subject to the statutory six-month priority over the existing mortgages. The property was worth $170,000 and encumbered by a $288,063 mortgage. Due to the “under water” property value, under bankruptcy law, only the $1,494 six month priority lien and part of the first mortgage had priority. The bankruptcy court held that the balance of the association’s claim was unsecured and could be modified – and treated as an unsecured claim.

On appeal, the District Court reversed, finding that the condo association held only one lien, with limited priority, which could not be modified because it was partially secured by the six-month statutory priority under the Condominium Act. As a result, the District Court held that the condominium lien must be paid in full.

The takeaway is that although many condo associations fear that an owner’s bankruptcy will negatively affect their ability to collect unpaid assessments, this is not necessarily so after the New Jersey Condominium Act’s interplay with the bankruptcy code. A community association should contact its attorney if it plans to challenge a bankruptcy petitioner-homeowner’s attempt to strip an assessment lien from the property.